Making every day count: Treasury and IRS issue Proposed Regulations on pro rata share rules for subpart F income and tested income/loss

On August 26, 2026, the Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) published proposed regulations, REG-115646-25 (Proposed Regulations), implementing changes to sections 951(a),¹ 951A, and 951B, as enacted in the One Big Beautiful Bill Act (OBBBA).

The Proposed Regulations provide guidance on how a United States shareholder, as defined in section 951(b) (US shareholder), calculates its pro rata share of a controlled foreign corporation’s (CFC) subpart F income, tested income, and tested loss, including rules related to closing CFC taxable years. The rules would generally apply for taxable years of foreign corporations beginning after December 31, 2025.

Background 

Former section 951(a)(1)(A) required a US shareholder to include in its taxable income its pro rata share of a CFC’s subpart F income only if the shareholder owned (within the meaning of section 958(a)) CFC stock on the last day of the CFC’s taxable year on which the corporation was a CFC (last-day rule). Under this rule, a US shareholder that sold its CFC stock before that last day did not have a subpart F inclusion. A US shareholder’s pro rata share was based on the amount the shareholder would have received if the CFC distributed its subpart F income on the last day of its taxable year on which it was a CFC, reduced by certain dividends paid by the CFC during such year.

The pro rata share rule also applied with certain adjustments to determine a US shareholder’s share of items, such as tested income, relevant to determining global intangible low-taxed income (GILTI) under section 951A.

Particularly in combination with the 100% dividends-received deduction (DRD) under section 245A for certain foreign-source dividends received from specified 10-percent-owned foreign corporations, the last-day rule created perceived gaps and planning opportunities. For example, a US shareholder could dispose of CFC stock prior to the last day of the CFC’s taxable year and avoid an inclusion of subpart F or GILTI tested income that accrued during its holding period. Further, if the CFC had distributed a dividend to the seller prior to the sale and during its same taxable year, such dividend could reduce the amount of subpart F income or GILTI tested income that a purchasing US shareholder was required to take into account, even though the dividend was offset by a section 245A DRD available to the seller. Treasury attempted to address this disconnect through various mechanisms, including the “extraordinary reduction” rules under Treas. Reg. § 1.245A-5(e) and (f), which limited application of the section 245A DRD and the section 954(c)(6) subpart F look-thru exception for dividends paid prior to a significant reduction in a US shareholder’s ownership of the CFC during the same taxable year.

What the OBBBA Changed

The OBBBA made several fundamental changes to the pro rata share rules, effective for taxable years of foreign corporations beginning after December 31, 2025. 

The OBBBA removed the last-day rule (except with respect to inclusions related to CFC investments in US property required under section 956). Now, a US shareholder must include its pro rata share of a CFC’s subpart F income and tested income or loss for purposes of section 951A (now net CFC taxable income (NCTI), rather than GILTI) if it owns stock of the CFC on any day during the CFC’s taxable year on which it is a CFC. The pro rata share is calculated based on the income attributable (as elaborated in the Proposed Regulations, discussed below) to the US shareholder’s stock for the portion of the year during which the US shareholder held the stock, was a US shareholder, and the corporation was a CFC. 

The OBBBA also eliminated the adjustment to a US shareholder’s pro rata share for dividends paid by the CFC. As a result of this change, the Proposed Regulations would eliminate the extraordinary reduction rules, because they are no longer necessary.

Under a transition rule, a dividend is not treated as a dividend that reduces a US shareholder’s pro rata share under prior section 951(a)(1)(A) if the dividend was (i) paid or deemed paid on or before June 28, 2025, and during the CFC’s year that includes such date and the US shareholder did not own the stock of the CFC during the portion of the year on or before June 28, 2025, or (ii) paid or deemed paid after June 28, 2025, and before a foreign corporation’s first tax year beginning after December 31, 2025. Notice 2025-75 described rules regarding the application of the transition rule, which are included the Proposed Regulations.²

Ratable Allocation Rules

The Proposed Regulations would determine the amount of subpart F income attributable to CFC stock owned by a US shareholder based on a daily proration (ratable allocation) approach, where income is allocated evenly through the year to the shares of stock outstanding on each day. Under this methodology, in a simple case where a CFC has only one class of stock and the same number of shares outstanding throughout the taxable year, a US shareholder’s pro rata share is determined by the following formula:

Pro Rata Share = Subpart F Income × (Shares Owned ÷ Total Shares Outstanding) × (Days of Ownership ÷ Total Days in CFC Year)

Treasury considered and rejected alternative approaches, including an interim closing-of-the-books method and special allocation rules for extraordinary items (e.g., from M&A transactions). These alternatives were rejected in part because the Code requires subpart F income (and tested income or tested loss) to be calculated on a net basis at the CFC level and then allocated to the CFC’s US shareholders. This contrasts with situations where existing extraordinary item exceptions apply, such as allocating partnership items or items of domestic corporations joining or leaving a consolidated group.

If a CFC has multiple outstanding classes of stock, the Proposed Regulations employ a two-step approach to allocation: (1) a hypothetical distribution first allocates the CFC’s subpart F income among the different classes of stock based on distribution rights, similar to the prior regulations, and (2) the daily proration methodology is then applied within each class to allocate among shareholders based on their ownership periods. The Proposed Regulations also address situations in which the total number of shares outstanding changes during the CFC year (e.g., due to stock issuances or redemptions) by using a weighted-average share count for purposes of the ownership fraction.

The Proposed Regulations’ pro rata share rules likewise apply for purposes of tested income and tested loss under section 951A.

The daily proration approach will require careful tracking of ownership periods, particularly in complex structures with multiple tiers of CFCs, mid-year transactions, and multiple classes of stock.

Year-Close Rules and Available Elections

Under the Proposed Regulations, a foreign corporation’s taxable year closes if a “status change event” occurs, that is, if the foreign corporation becomes or ceases to be a CFC. A mandatory closing occurs at the end of the day before the corporation becomes a CFC or the end of the day on which it ceases to be a CFC. This year end closing event applies for all purposes of the Code, and with respect to all shareholders.

The Proposed Regulations also allow US shareholders to elect to close a CFC’s taxable year in certain circumstances. A CFC’s taxable year may be closed when there is a “significant ownership variance” (SOV). An SOV is a more-than-50-percentage-point decrease in ownership by section 958(a) US shareholders resulting from specified transfers pursuant to the same plan. Related-party transfers do not count toward the 50% SOV threshold, nor do transfers made in section 368(a)(1)(F) reorganizations.

To make the election, each of the “controlling section 958(a) US shareholders” (those whose ownership decreases) must file a statement with its timely (including extensions) original federal income tax return for its taxable year that includes the date on which the CFC’s taxable year ends pursuant to the election. A written, binding agreement to make the election generally must be entered into by the controlling section 958(a) US shareholders and any other US shareholder that held CFC stock at any point during the year up to the SOV date (but not counting a shareholder that first acquires its stock on the SOV date). No agreement is needed where there is a single controlling section 958(a) US shareholder and no other relevant US shareholders.

If SOVs occur with respect to multiple CFCs pursuant to the same plan or series of related transactions, the election is available only if it is made for every affected CFC (i.e., US shareholders may not elect to close the taxable year of some of those CFCs but not others).

If a CFC’s US taxable year closes (under either the mandatory rule or pursuant to an election) before its foreign taxable year ends, a portion of the foreign income tax for the year is allocated back to the pre-closing year in proportion to the foreign taxable income in each period.

Eversheds Sutherland Observation: The elective closing mechanism will be significant in M&A transactions involving transfers of CFCs mid-year. Buyers will want to model the results of such election and compare them with those of a section 338(g) election, which results in a deemed asset sale as well as an end of the taxable year. In certain cases, such as where there is a built-in loss in a CFC’s assets, the closing election may provide a comparative benefit by not stepping down the basis in the assets.

 

Section 951B Rules 

The OBBBA also added Section 951B, which extends the subpart F and NCTI regimes to foreign controlled United States shareholders (FCUSS) and foreign controlled foreign corporations (FCFC).

An FCUSS is a US person that would be a US shareholder of a foreign corporation if the 10% ownership threshold were replaced with “more than 50%” and section 958(b)(4) (the anti-downward attribution rule) were disregarded. An FCFC is a foreign corporation, other than a CFC, that would be a CFC if the test were applied by reference to FCUSSs (rather than US shareholders) and section 958(b)(4) did not apply. Thus, FCUSSs are generally foreign corporations that are not CFCs but are under common control with one or more US corporations. 
The Proposed Regulations determine an FCUSS’s required inclusions under section 951B by applying the same pro rata share rules to FCUSSs and FCFCs, substituting the relevant defined terms to be consistent with the remaining changes.

More Reporting on Form 5471

Section 6038 and the related regulations require every US person that controls a foreign business entity to report specified information on Form 5471 (Information Return of US Persons with Respect to Certain Foreign Corporations).

The Proposed Regulations specify additional information regarding a foreign corporation’s stock and its shareholders that is required to be reported on Form 5471, including:

• a description of the class of stock, 
• the number of shares of each class of stock, 
• information regarding issuances, redemptions, or other changes in the number of shares, and
• a description of the stock held by each person that directly owns (within the meaning of section 958(a)) and each US shareholder that indirectly owns (as described in section 958(a)(2)) stock in the foreign corporation. 

Comment Period and Reliance

Comments on the proposed regulations are due by October 26, 2026, and Treasury intends to finalize the regulations by January 4, 2027. Taxpayers may rely on the Proposed Regulations before finalization if they apply them consistently and in their entirety.

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If you have any questions about this Legal Briefing, please feel free to contact any of the attorneys listed or the Eversheds Sutherland attorney with whom you regularly work.

_{1 Unless otherwise stated, all section references are to the Internal Revenue Code of 1986, as amended (Code), and all “Treas. Reg. §” references are to the regulations promulgated thereunder by the Treasury as in effect as of the date of this client alert, as relevant.} 

_{2 Notice 2025-75, 2025-52 I.R.B. 867. We previously published a client alert explaining the transition rules here.}